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July 10, 2013

Rogoff on Gold: ‘Not Much Has Changed Since 2010’

Famed economist warns policymakers to be ‘cautious’ in reacting to the precious metal’s latest plunge

Gold’s stratospheric run during the height of the economic crisis and its aftermath served as an effective hedge against the possibility of even more disaster to come. It should hold, therefore, that gold’s collapse would signal a vote of confidence in the way markets are currently performing.

That's the scenario laid out by the famed economist Kenneth Rogoff in a blog posted to The Guardian’s website on Tuesday. So is it, in fact, what’s happening?

Yes and no, Rogoff writes, with typical academic fuzziness.

“To say that the gold market displays all of the classic features of a bubble gone bust is to oversimplify,” Rogoff (left) argues. “There is no doubt that gold's heady rise to the peak, from around $350 per ounce in July 2003, had investors drooling. The price would rise today because everyone had become convinced that it would rise even further tomorrow.”

The case for buying gold had several strong components, he goes on to explain. Ten years ago, gold was selling at well below its long-term, inflation-adjusted average. The integration of 3 billion emerging-market citizens into the global economy could only mean a giant long-term boost to demand.

“That element of the story, incidentally, remains valid,” Rogoff notes. “The global financial crisis added to gold's allure, owing initially to fear of a second Great Depression. Later, some investors feared that governments would unleash inflation to ease the burden of soaring public debt and address persistent unemployment.”

In fact, the case for or against gold has not changed all that much since 2010, when he last wrote about it. In October of that year, he notes, the price of gold was on the way up, having just reached $1,300. But the real case for holding it was never a speculative one. Rather, gold is the aforementioned hedge. For a high-net-worth investor, or a sovereign wealth fund, it makes perfect sense to hold a small percentage of your assets in gold as a hedge against extreme events.

Stepping into his Wayback Machine, he points to research from Stephen Harmston's oft-cited 1998 study pointing to anecdotal evidence that an ounce of gold bought 350 loaves of bread in the time of Nebuchadnezzar II, king of Babylon, who died in 562 BC.

“Ignoring the fact that Babylon's bread was probably healthier than today's highly refined product, the price of gold today is not so different, equal to perhaps 600 loaves of bread. Of course, we do not have annual data for Babylonian gold prices. We can only assume, given wars and other uncertainties, that true market prices back then, like today, were quite volatile.”

He concludes buy noting the recent collapse of gold prices “has not really changed the case for investing in it one way or the other. Yes, prices could easily fall below $1,000, but, then again, they might also rise. Meanwhile, policymakers should be cautious in interpreting the plunge in gold prices as a vote of confidence in their performance."